Ricardo's Big Idea, and Its Vicissitudes

Ricardo believes in labor value prices because capital flows to put people to work wherever those things can be made with the fewest workers. This poses a problem for Ricardo: The LTV tells him that capitalist production should take place according to absolute advantage, with those living in countries with no absolute advantage left in subsistence agriculture.

The doctrine of comparative advantage is Ricardo’s way out. For him, the LTV holds within countries. Countries’ overall price levels relative to each other rise and fall as a result of specie flows until trade balances. And what is left is international commodity price differentials that follow comparative advantage. Merchants profit from these differentials, and their demand induces specialization.

Thus Ricardo reconciles his belief in the LTV with his belief in Hume’s “On the Balance of Trade“ and with the fact that capitalist production is not confined to the industry-places with the absolute advantage. His doctrine reconciles his conflicting theoretical commitments with the reality he sees, as best he can.

By now, note that we are far away from the idea that “comparative advantage” justifies the claim that free trade is for the best in the best of all possible worlds. There are a large number of holes in that argument:

Optimal tariffs.

The fact of un- and underemployment.

Externalities as sources of economic growth, in any of the “extent of the market”, “economies of scale”, “variety”, “learning-by-doing”, “communities of engineering practice”, “focus of inventive activity”, or any of its other flavors.

Internal misdistribution means that the greatest profit is at best orthogonal to the “greatest good of the greatest number” that policy should seek.

Given these holes, the true arguments for free trade have always been a level or two deeper than “comparative advantage”: that optimal tariff equilibrium is unstable; that other policy tools than trade restrictions resolve unemployment in ways that are not beggar-thy-neighbor; that countries lack the administrative competence to successfully execute manufacturing export-based industrial policies; that trade restrictions are uniquely vulnerable to rent seeking by the rich; and so forth.

The only hole for which nothing can be done is the internal misdistribution hole. Hence the late 19th C. “social Darwinist” redefinition of the social welfare function as not the greatest good of the greatest number but as the evolutionary advance of the “fittest“—that is, richest—humans.

Hence “comparative advantage” takes the form of an exoteric teaching: an ironclad mathematical demonstration that provides a reason for believing political-economic doctrines that are in fact truly justified by more complex and sophisticated arguments. And, I must say, arguments that are more debatable and dubious than a mathematical demonstration that via free trade Portugal sells the labor of 80 men for the products of the labor of 90 while England sells the labor of 100 men for the products of the labor of 110.

But even if you buy all the esoteric arguments that underpin the exoteric use of comparative advantage on the level of national political economy, there still is the question of the global wealth distribution. Stipulate that the Arrow-Debreu-Mackenzie machine generates a Pareto-optimal result. Stipulate that every Pareto-optimal allocation maximizes some social welfare function. What social welfare function does the Arrow-Debreu-Mackenzie machine maximize.

It maximizes the social welfare function with Negishi weights. When individual utilities are weighted before they are added, each individual’s is waited by the inverse of their marginal utility of wealth. If the typical individual utility function has curvature that corresponds to a relative risk aversion of one, then Negishi weights are proportional to each individual’s wealth. For a relative risk aversion of three, Negishi weights are proportional to the cube of each individual’s wealth.

“Comparative advantage” is the market economy on the international scale. And the market economy is a collective human device for satisfying the wants of the well-off. And the well-off are those who control scarce resources useful in producing things for which the rich have a serious Jones.

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